http://www.jewishworldreview.com --
OIL, MONEY AND INTEREST RATES have historically been an inflammable
mix. Today, it seems to be no different. Not even the new era
information economy is yet immune from the oil factor. An
unexpected oil price shock has driven Treasury bond rates
significantly higher this year, halting the stock market advance.

Most Fed watchers now believe the central bankís overnight policy
rate will be raised a quarter point at the June 30 FOMC meeting; futures markets have
priced in a second Fed snugging in the fourth quarter. Economists will be forced back to
their drawing boards in order to revise down their growth forecasts in the wake of higher
oil prices.

Life is full of surprises. Two years ago it was the Asian collapse. Last year was the
Russian meltdown. This year itís oil. Makes forecasting an exercise in humility.

It is especially noteworthy that most forecasters are blaming an "overheated" economy
as the chief culprit behind this yearís interest rate rise and related flare-up of inflation
fears. Hauling out their Phillips curves -- which incorrectly posit an inverse trade-off
between falling unemployment and rising inflation -- mainstream economists in and
outside the Fed are singing a familiar tune: growth must be slowed lest inflation rise.

A 4.2% jobless rate is way below the so-called non-accelerating inflation rate of
unemployment (NAIRU), they say, despite the fact that both unemployment and inflation
have been falling together for years. Bond traders seem to hate jobs; except, of course,
their own. In this limits-to-growth Malthusian model of pessimism more people working
and prospering is a bad thing. Tch, tch. No wonder economics is called the dismal
science.

Notwithstanding the Keynesian chorus, I
believe that OPECís rigging of higher oil
prices is mainly responsible for rising
rates, not the healthy economy. Just
look at recent history. In 1997, oil
averaged $20.60 per barrel, with Treasury
yields hovering close to 7%. Last year,
however, oil dropped 29% to a calendar
average of $14.40. Right on cue, the
30-year Treasury bond dropped roughly a
third to less than 5%. Today, with oil
ranging close to $18 per barrel, a 25%
price hike over 1998, long bond rates are
approaching 6ľ%, about the same
magnitude of gain as oil.

Coincidence? I donít think so. Temporary oil shocks have always affected interest rates
and the economy. Last year, for example, the economy surged from only 1.8% growth
in the spring quarter to 6% in the autumn period as oil prices declined sharply. Nearly
everyone was fretting about deflationary recession imported from Asia and Russia, but
slumping oil and falling interest rates actually generated a highly stimulative tax-cut
effect that lowered inflation and raised growth.

The 1998 experience was the mirror image reversal of the 1970s, when a quadrupling of
oil prices led to stagflation and sky-high interest rates. The stock market lost nearly
two-thirds of its real value. Importantly, though, misguided Federal Reserve policies
during those years of malaise aided and abetted the economic decline.

In a mistaken attempt to offset the contractionary nature of the big oil shock in the
Seventies, the Fed under Arthur Burns and G. William Miller pumped in more and more
money. Gold and other commodities soared, while the dollar slumped. This easy-money
accommodation succeeded in turning a temporary inflation of oil into a decade-long
inflation of all goods and services. Higher inflation amounted to a huge tax hike that
impoverished the economy by depressing growth, productivity and real wages. By the
way, for you Phillips curvers out there, inflation and unemployment went up together.

Alan Greenspan has a good grasp of this history, and this may explain why he is likely
to restrain credit a bit this summer. Not to prevent growth, but to avoid monetizing higher
oil prices into a general inflation increase that could take several years -- and a
recession -- to snuff out.

Incidentally, Greenspan acted similarly in 1990. Despite the onset of recession, the Fed
refused to ease policy when the Iraq invasion of Kuwait temporarily drove oil prices to
nearly $40 per barrel. It was this restraint, along with subsequent tightening moves to
counter rising commodity prices in 1994, that led to virtually zero inflation and price
stability over the past three years.

As for todayís oil problem, it wonít take much from the Fed to limit the inflationary
potential because itís not much of a problem. We know this because falling precious
metals, stable commodity indexes and a strong dollar are all signaling that future
inflation over the next year will actually be lower than it is today. These market-based
commodity indicators have a much more accurate inflation-forecasting record than the
unemployment rate or the pace of economic growth.

Remember, inflation is caused by a drop in dollar purchasing power, not prosperity. A
general increase in all prices, not just oil (or wages), is possible only when money
supplied by the Fed is greater than the markets and the economy demand. The price of
gold, the CRB index and the dollar index are the best measures of "excess money."
Think of them as an advance scouting party; they are early warning indicators of
monetary over-abundance and future inflation. Right now these "price rule" signals
suggest that money is scarce, not loose.

So I donít have much enthusiasm for a Fed-tightening move. Itís not the 1970s. The oil
hike will be temporary, and a King dollar-linked $260 gold price tells me that monetary
policy is already tight. Then again, if new technologies have reduced the cost of
producing oil to about $7 per barrel in West Texas, and $4 per barrel in the North Sea,
even $18 oil canít last for very long. OPEC may think itís in control, but the world market
will prove to be the eventual winner. Over time, selling prices will converge with
production costs.

Actually, over the past three decades, one ounce of gold, on average, purchases 20
barrels of oil. So, if gold stays around $260, then oil could drop to $13 per barrel. And
that would be consistent with 4Ĺ% to 5% long Treasury rates, as the underlying
inflation trend edges below 1%. Capitalizing 3% to 5% expected corporate profits with a
5% discount rate would greatly expand price-earnings multiples and boost the stock
market over the next year. Keep optimism alive.

As for the Fed, if they must tighten to offset higher oil -- last year they eased when oil
dropped -- I wonít lose much sleep over it. Call it opportunistic disinflation. But
unnecessary Fed tightening does risk a bigger near-term stock market correction. It will
reduce growth over the next year by roughly one-half of a percentage point. Subtract
another 1% from growth as business firms complete their Y2K investment upgrades.
Also, incipient recoveries in Europe, Asia and Latin America may be injured. For the
Y2K presidential race, Al Goreís polls will suffer.

Hereís a better idea for Greenspan and Co. Take a short ride over to the Justice
Department, where all those former Jimmy Carter anti-trust busters are working their
keysters off to prosecute pro-consumer Microsoft and Intel, which are producing more
technology goods at lower prices, but have not uttered one peep about OPEC, whose
anti-consumer and anti-growth policies are conspiring to produce less oil at higher
prices.

We know that at least one American oil company, Chevron, is colluding with OPEC. So
thereís a legal hook to hang on. The Fed might suggest regulatory action against a real
monopolist, namely OPEC. And that would hasten the decline of oil prices. Sure beats
a monetary dose of castor
oil.